I warned many about the coming crisis, long before it happened, on many occasions and in many places, even at the World Bank. They did not want to listen and that´s ok, it usually happens, but what is not ok, is that they still do not seem to want to hear it. “We can easily forgive a child who is afraid of the dark; the real tragedy of life is when men are afraid of the light.” (Plato: 427 BC – 347 BC)

Saturday, April 30, 2011

Since you still seem to be completely unaware of it, let me put forward a kindly reminder:

There has never ever been a major bank crisis caused by excessive lending or investments to what was perceived as risky, and these have all resulted from either unlawful behavior or excessive lending or investment into what was perceived as not risky, but later turned out to be.

Against that fact your capital requirements, based on the perceived risk, as perceived by your official risk-perceivers, the credit rating agencies, that establishes higher capital requirements for what is perceived as risky and lower for what is perceived as not risky, seems to be sort of a dumb idea. If anything, on a purely empirical basis, higher capital requirements for what is perceived as not risky would make more sense.

And, while I am at it, let me also remind you that the banks already use the information provided by the credit rating agencies when deciding what amounts and at what margins to lend to a client, and so to force them to also consider these for their capital base, gives the credit ratings a double weight, and, as we all know, even the best information, if it is excessively considered, is wrong.

By the way, your capital requirements, amount to an outright discrimination of those who we most need our banks to attend, the small businesses and entrepreneurs. Shame on you!

Monday, April 18, 2011

The regulators notwithstanding that the market and the banks already considered the credit ratings when setting their risk premiums and interest rates, considered exactly the same information when setting their capital requirements for the banks. This double consideration, which would have been wrong even in the case of perfect credit ratings, leveraged incredibly the systems dependence on the human fallible credit ratings.

And now, more than three years into the crisis, the Basel Committee, FSB, FAS, Fed, IMF, World Bank, PhDs and finance experts, specialized journalists, like all those in FT, and most other who have and give opinions on the issue of bank regulations, have yet to say one single word about a mistake that really makes it impossible to construe any worthy bank regulation on top of it.

One really wonders what world we live in, when the regulators is turning our whole banking system sissy... and making it impossible for banks to allocate credit efficiently to the real economy.

Saturday, April 16, 2011

There was once a family where mother father, elder brothers and sisters and, of course, the grandparents, all lovingly cared for the well-being of the youngest family member, little Bob. For instance, they always informed little Bob about the risks they perceived existed in park AAA when compared to those present in the riskier park BBB. But, that said, they were also very careful of not producing any undue temerity in little Bob, since, besides wanting him to grow up and become a daring man, and not remain a frightened boy, they also knew he needed to go and play in park BBB, quite often, because there was where he could get the exercise that could make him strong. All in all, little Bob was growing up nicely.

Unfortunately, one day the family hired a governess to watch out over young Bob, Fraulein Basel. She, scared stiff she would be blamed for anything bad that could happen to little Bob, promised him a whole chocolate cake every day, if he would only go and play in the super-safe park AAA. Little Bob, as any healthy young boy, was naturally thrilled with the idea, and thereafter visited only park AAA. But, after eating a whole cake every day, one day in park AAA, suddenly, out of the blue, an extremely slow but yet venomous snake appeared, and little obese Bob could not run away, and so little Bob tragically died.

And that my friend is what happened to our banks when we placed them in the overly caring nervous hands of Fraulein Basel Committee.

But now, more than three years into a crisis that has caused so much misery around the world, we have yet to hear the World Bank and the IMF or anyone else for that matter commenting on the role of Fraulein Basel’s stupid chocolate cake.

And our banks are still in Fraulein Basel hands even though we know she has not abandoned the stupid idea of the chocolate cake, and thinks it is only a matter of a better chocolate cake, Basel III; which she will soon present to another little Bob… or Hans… or Pedro… since her reach is global.

Translation: The mother of all regulatory mistakes

The Basel Committee even though they knew that banks were already considering the information on risks of default when they calculated the risk premiums and set the interest rates, decided to use that same risk information to set their capital requirements. Of course, considering the same risk information twice, exposed the bank more than ever to the very real possibility of that risk information not being perfect.

That stupid and unforgivable mistake resulted in:

1. The setting of minimalist capital requirements that served as growth hormones for the ‘too-big-to-fail’.

2. That banks overcrowded and drowned themselves in shallow waters, whether of triple-A rated securities backed with lousily awarded mortgages to the subprime sector, or of equally or slightly less well rated “infallible” sovereigns, like Greece.

3. A serious shrinkage of all bank lending to small businesses and entrepreneurs, as lending to these generated, in relative terms, much higher capital requirement, which made it difficult for them to deliver a competitive return on bank equity.

And the dumb regulators have still not understood, that you do not regulate banks based on perceived risks, but based on what banks might do with perceived risks.

On April 28, 2004 the Securities and Exchange Commission authorized the investment banks to dramatically increase their leverage, among other when investing in securities backed by mortgages to the subprime sector. The SEC resolution establishes the explicit condition that it has all to be done “consistent with the Basel Standards”.

The Report of 650 pages, does not mention the Basel Committee once!

And why do the Basel Standards, issued by the Basel Committee matter? The answer is simple; it was the Basel Committee which produced and disseminated the regulatory mistake that caused this crisis. Here follows a very brief description of that fatal mistake.

The Basel Committee’s mistake

If all sovereign and private bank clients were paying the banks exactly the same risk-premiums, then the risk-weights used in Basel II to apportion the basic capital requirements for banks according to the various categories of credit ratings could have been right. But, they don’t!

The banks and the markets already incorporates in the setting of their risk-premiums the risk information provided by the credit rating agencies, and so when the regulators also used the same credit ratings for setting their risk-weights they made these ratings count twice. That huge mistake resulted in:

1. The setting of minimalistic capital requirements that served as growth hormones for the ‘too-big-to-fail’.

2. That banks overcrowded and drowned themselves in shallow waters, whether of triple-A rated securities backed with lousily awarded mortgages to the subprime sector, or of equally or slightly less well rated “rich” sovereigns, like Greece.

3. A serious shrinkage of all bank lending to small businesses and entrepreneurs as lending to these generated, in relative terms, much higher capital requirement, which made it difficult for them to deliver a competitive return on bank equity.

With Basel III, regulators might be trying to correct for this mistake, instead of correcting the mistake. In other words, the Basel Committee is digging us deeper in the hole where they placed us.

Sunday, April 10, 2011

The market, looking at all risk information, which includes that of the credit rating agencies establishes some risk premiums that will make lending to different perceived risks equivalent. But then tha Basel II regulators made the mistake of using the same information provided by the credit rating agencies by mean of the risk-weights they applied and in doing so discriminated excessively in favor of what was officially perceived as having a very low risk of default. the AAAs. The following table illustrates the gigantic magnitude of that regulatory anti-risk-bias for a figurative example of how the market could be viewing a AAA risk versus a Not Rated risk:

Wednesday, April 6, 2011

“Inside Job” the Oscar winning documentary on the financial crisis that has put the global financial stability in jeopardy touches upon most issues and actors involved, spending even several minutes of the role of cocaine and prostitutes. Yet, amazingly, it does not mention even once the Basel Committee for Banking Supervision, the global bank regulator and that in my opinion is the one most to blame for the crisis.

Should it? In one of the opening scenes of “Inside Job” refers to the Securities and Exchange Commission’s meeting on April 28, 2004 when the SEC authorized the investment banks to dramatically increase their leverage, among other when investing in securities backed by mortgages to the subprime sector. That SEC resolution explicitly made an explicit reference that it has all to be done “consistent with the Basel Standards”.

Is “Inside job” doing an inside job on us?

Friday, April 1, 2011

The Basel Committee for Banking Supervision, speaking for all sophisticated bank regulators around the world, issued today an urgent statement regarding the discovery of a fundamental mistake committed in Basel II and which they now understand was responsible for causing the current financial crisis.

The mistake was that though the markets and the banks were already incorporating the information about the possibilities of default that were contained in the credit ratings when calculating the corresponding risk premiums to set interest rates for their clients, the regulators based the capital requirements for banks on exactly the same credit ratings, and so, unwittingly, accounted for said credit information twice.

The result of it was, of course, the excessive financing of everything that was officially deemed as having a low risk of default, like whatever had swell ratings like Greece and securities backed by lousily awarded mortgages to the subprime sector; and the insufficient financing of whatever was officially deemed as more risky, like the small businesses and entrepreneurs who are vital for maintaining that dynamism of the economy that creates jobs.

The Basel Committee expresses its most sincere regrets for such a mistake and promises to take immediate corrective action.

PS. April Fool´s joke disclaimer: Sorry, unfortunately, the Basel Committee and the sophisticated bank regulators, three years into a crisis of its own making, are still not (publicly) aware of their mistake.

The Independent Evaluation Officer of the International Monetary Fund has recently in an Evaluation Report come to the conclusion that, for IMF at least, “the ability to correctly identify the mounting risks was hindered by a high degree of groupthink…” The reason why the truth of what happened does not come out must probably now be attributed to group-interests.

Follow by Email

Why don't bank regulators get it?

The less the perceived risk of default is, and the higher the leverage allowed, the greater the systemic risk.

My huge problem!

Q. "If Kurowski is right, why are his arguments so ignored? A. If I had argued that the regulators were 5 to 10 degrees wrong, I would be recognized, but since I am arguing they are 150 to 180 degrees wrong, I must be ignored.

The deafening noise of the Agendas

The fundamental reasons why it is so hard to advance the otherwise so easy explainable truth of this financial crisis, is because of the deafening noise of the Agendas…

On one side, we have the "progressives" who want to put all the blame on capitalistic banksters, and, on the other, the "conservatives" who want to blame the socialistic government sponsored enterprises GSEs of Fanny Mae and Freddy Mac.

For any of both sides accepting the fact that it was mostly a regulatory failure of monstrous proportions would seemingly be a highly inconvenient truth that would not help them to advance their respective agendas.

You tell me!

What is more dangerous in a systemic way, that which is perceived as risky or that which is perceived as not risky? Right!

How can the Basel Committee be so dumb?

Systemic risks is about something that can become as big so as to threaten the system… and our bank regulators in the Basel Committee are incapable or unwilling to understand that what has the largest possibilities of growing as big so as to threaten the system is what is perceived as having little or no risk, not what is perceived as risky… which makes their first and really only pillar of their regulations, that of capital requirements of banks that are lower when perceived risks are lower… so utterly dumb!

We must stop our gullible and naive financial regulators from believing in never-risk-land.

The stuff that bonuses are made of

Whenever a credit rating corresponds exactly to real underlying risk neither borrower nor lender loses but the intermediary cannot make profits… it is only when the credit ratings are too high or too low that those margins that can generate that profitable stuff that bonuses are paid for exist.

What were they thinking?

The default of a debtor is about the most common, natural and even benign risk in capitalism, so it is so hard to really get a grip on what was going around in the minds of the regulators when they decided to construe capital requirements for banks based exclusively on discriminating against that risk as it was perceived by some credit rating agencies.

Day by the day it is becoming more relevant... scary!

This I published in November 1999... Read it!

The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of the OWB (the only bank in the world) or of the last financial dinosaur that survives at that moment.

Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.”

This I wrote, October 2004, as an Executive Director of the World Bank

We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.

Regulatory hubris

In a world with so many different risks, some naïve gullible and outright stupid regulators thought everything would be fine and dandy if they just had some few credit rating agencies determine default risks and then gave the banks great incentives, by means of different capital requirements, to follow those credit risk opinions.

On bs.

When experts bs..t the world that’s bad news, but when experts allowed themselves to be bs..ted by bs..ing experts that’s is when the world goes really bad.

My most current proposal on the regulatory reform for banks

Fire the teachers!

They were supposed to teach the world prudent risk-taking and instead they taught it imprudent risk-aversion.

The deal!

This was the deal! If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Fred that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred the mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000

Calling it quits?

A world that taxes risk-taking and subsidizes risk adverseness is a world that seems to want to lie down and die

Let´s neutralize the wimps!

If we are to keep on using Basel methodology for establishing the minimum capital requirements for banks, beside better risk weights, we must demand it also uses “societal purpose” weights.

Search This Blog

Subscribe To

Silly bank regulators!

What other word could describe a bank regulatory system designed exclusively to avoid bank crisis as if that is the only purpose of banking. You might just as well order the kids to stay in bed all life so as to diminish the risk of them tripping.

The minimum capital requirements of Basel that are based on default risks as measured by the credit rating agency amount to a dangerous tax on the risk, the oxygen of development.

Blindly focusing on default and leaving out any consideration that a credit with a low default risk but for a totally useless or perhaps even an environmentally dangerous purpose is much more risky for the society than a credit with a higher default risk destined to trying to help create decent jobs or diminish an environmental threat, is just silly.

But do I have to be disrespectful and call them silly? Well, individually perhaps they are not, but, as a group, bank regulators are so full of hot air that someone has to help them to puncture their cocoon balloon and let them out.

Breathe!

I’m going to third-pillar what?

By now the desperate bank regulators are throwing at us the third pillar of their Basel regulations which implies the need that we ourselves privately monitor our banks. Great, in my country, a couple of decades ago, I did just that and had a fairly good grip on whom of my banker neighbors were good bankers and whom to look out for.

But sincerely what am I supposed to do know when about 50 per cent of the retail deposits in my country are in hand of international banks (Spain) and that might be losing their shirt making investments in subprime mortgages in California?

Tragedy!

It is very sad when a developed nation decides making risk-adverseness the primary goal of their banking system and places itself voluntarily on the way down but it is a real tragedy when developing countries copycats it and fall into the trap of calling it quits.

Development rating agencies?

A bank should be more than a mattress!

When considering the role of the commercial banks should not the developing countries use development rating agencies instead of credit rating agencies?

Clearly more important than defending what we have is defending what we want to have.

What do we want from our banks?

Over the last two decades we have seen hundreds if not thousands of research papers, seminars, workshops conferences analyzing how to exorcize the risks out of banking; and if in that sense the bank regulation coming out from Basel was doing its job; and centred around words like soundness, stability, solvency, safeness and other synonyms. Not one of them discussed how the commercial banks were performing their other two traditional functions, namely to help to generate that economic growth that leads to the creation of decent jobs and the distribution of the financial resources into the hands of those capable of doing the most with it.

At this moment when we are suddenly faced with the possibilities that all the bank regulator’s risk adverseness might anyhow have come to naught, before digging deeper in the hole where we find ourselves fighting the risks, is it not time to take a step back and discuss again what it is we really want our commercial banks to do for us? I mean, if it is only to act as a safe mattress for our retail deposits then it would seem that could be taken cared of by authorizing them only to lend to the lender of last resort; but which of course would leave us with what to do about the growth and the distribution of opportunities.

About Me

We are suffering from more and more answers than questions begging for them, and so I work on the latter.
Read it all in my one and only book!"Voice and Noise"
Pssst... so few have read this book so it is slowly turning into a collector item (I do not say a "cult"... yet) and so you might benefit from getting your very own copy now.